Many small businesses start out very small – often as one person tapping away on their laptop, trying to make their vision a reality. But as ideas develop, a small business can take on a life of its own. When that happens, or even before that happens, it can be very advantageous to take the steps to incorporate your small business. And aside from the positive advantages of incorporation, there can be major pitfalls in failing to incorporate.
Stepping back, it is important to know what exactly happens when you incorporate your business. Essentially, incorporation turns your business in to its own legal entity. Whether you run a shop on Main Street, a website selling a unique service, or an office with several employees, incorporation provides much-needed legal separation between you and your business.
The most obvious advantage of incorporating a small business is limited liability. If you run a sole proprietorship—that is, you operate a business alone—you and your business occupy the same legal space. The same is true when you run your business as a basic partnership. When your business is sued and you have not incorporated, you may be personally liable for judgments against your business. Furthermore, if your business debt obligations spin out of control, creditors may be able to reach your personal assets. This means your house, car and life savings may be in jeopardy for situations you assumed only related to your business. Incorporation ensures that your personal assets remain untouched when your business faces legal or debt liability.
Incorporation can also provide various tax benefits which can help your bottom-line as your business grows. As such, choosing the right corporate form is vitally important. For example, a C-Corp (what is most commonly thought of as a “traditional” corporation) can take in income with a lower tax rate than most individual income tax rates and potential deductions are more plentiful. One potential issue with C-Corps comes when the corporation issues dividends to shareholders and that money is taxed again as the shareholder’s personal income. Corporate income tax can combine with the dividend tax and result in “double taxation.”
To address double taxation and other issues of corporate formality, many businesses incorporate as an LLC, or “Limited Liability Company.” A business forming as an LLC can choose which legal tax status best suits the business and its owners—that of a C-Corp, S-Corp, partnership, or even sole proprietorship. LLCs can allow for “pass-through” taxation which treats company income as passing through directly to the owner(s), thus avoiding any taxes taken “off the top.” In this way, an LLC can provide the best of both worlds by, (1) limiting its owners’ personal liability on business-related legal and debt issues, and (2) avoiding the formalities and double taxation associated with traditional incorporation.
When it comes to choosing a method of incorporation, there is no one-size-fits-all approach. Every business has its unique goals, challenges and aspirations. At Shenon Law we are committed to meeting our clients’ unique needs and helping them realize their long-term growth potential. If you are considering forming a C-Corp, S-Corp, LLC or just need to discuss what options are available, Shenon Law is here to help.